Deep Value Investors Will Love This Stock

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Computer Sciences Corp (NYSE: CSC) has long been a favorite holding of David Einhorn, whose confidence in the company's turnaround is starting to pay off. Already having doubled in market price since Einhorn's investment, the company still trades for just 7.5 times trailing earnings.

Meanwhile, Computer Sciences continues its efforts to boost margins, which have only recently recovered to the level experienced before the company took a big bath in 2012.

In fact, the company is already exceeding Einhorn's expectations; the activist investor stated at the time of his purchase that he expected the company to eventually earn $4 to $5 per share. Over the last four quarters, the company earned over $6 per share. If the company can maintain this level of profitability, the stock -- now trading at around $45 per share -- is a bargain.

No moat, but a decent business

Computer Sciences does not have a durable competitive advantage that will enable it to earn outsized profits for decades into the future. However, the company currently has a significant advantage in expertise and IP in its core markets, in addition to a long history of good relations with government customers. Although the company's reliance on government spending could sink the company if austerity measures are imposed by Congress, such a scenario is unlikely to occur in the near future.

Instead, Computer Sciences' main obstacle comes in the form of Cognizant Technology Solutions (NASDAQ: CTSH) and other competitors. Although Cognizant is not as reliant on government contracts as Computer Sciences -- Cognizant is focused on growth in Western Europe -- it poaches more than its fair share of highly-trained employees from Computer Sciences. As the battle for qualified employees intensifies, Computer Sciences and Cognizant will continue to grow their backlogs and employee salaries will continue to rise.

However, Cognizant's raid on employees is not likely to come to an end any time soon. As a latecomer to the fast-growing European market, the company has some catching up to do; it is aggressively expanding in the region. In addition, the company is also having trouble filling employment vacancies in its U.S. business; the company relies on American personnel to recruit and retain American customers. These personnel concerns make a long battle for employees a likely scenario.

Despite Computer Sciences' deep relationships with U.S. state and federal governments, the company earns significantly lower returns on invested capital than Cognizant.

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This is due in part to differences in product mix, but primarily to differences in cost structure; Cognizant employs American consultants but outsources other functions to cheaper laborers in India, while Computer Sciences relies primarily on workers located in the same geography as its customers. As a result, it does not earn as much per dollar invested in the business.

A comparison company

Computer Sciences is a decent business in the late stages of a turnaround that trades for just 7.5 times earnings. A good comparison company is Infosys (NYSE: INFY), which trades at 13.5 times earnings.

Infosys is an example of a company that earns high and stable margins even during recessions. The company's offering is quite different than Computer Sciences', but it is important for investors to compare investment opportunities across situations.

Infosys has an extensive customer network and generates lots of free cash flow. This is largely due to its capital-light structure, which allows it to grow without significant additional investment. In addition, earnings per share have tripled over the last decade, which demonstrates the company's ability to grow.

As one of the largest IT service providers, Infosys enjoys the benefits of superior scale and an unmatched product offering. This gives the company the semblance of a moat, which allows it to earn outsized profits. In other words, Infosys has a durable competitive advantage, while Computer Sciences does not.

Infosys translates its competitive advantage into outsized profits. Like Cognizant, Infosys earns much higher returns on capital than Computer Sciences. This is because Infosys not only outsources work overseas, but it also dominates service offerings for financial services, manufacturing, and retail customers. The company's dominance of its primary markets puts it on much firmer footing than Computer Sciences.

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Bottom line

Investors have the choice between investing in the tail end of a turnaround at 7.5 times earnings or investing in a much better business with a long history of profitability at 13.5 times earnings. Both companies offer about the same risk/reward proposition, which makes the investment decision come down to one thing: style. Deep value investors should go for Computer Sciences, while investors looking for good businesses should go with Infosys.

Ted Cooper has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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